Tuesday, September 13, 2016
10:27:04 PM EDT

The Trend Has Changed

by
Jim Brown

The sudden appearance of volatility and the Dow falling 4 out of 5 days is a not so subtle warning.

Market Statistics

I write often that one day does not make a trend. However, five days is a good indication that the prior trend has changed. It does not mean we are about to experience a 5-10% correction but the implications of the recent market action suggest we should consider that potential.

The Dow has posted alternating 200+ point moves over the last three days. Three alternating 1% or move moves are very rare. One analyst said it has happened only a handful of times in the last 20 years. Typically when a trend breaks and a decline begins there will be rebounds but not of this magnitude. Normally there will be several days of declines and then a big short squeeze before the decline resumes.

Having three alternating 200-point moves back to back suggests there is significant uncertainty that has escalated rapidly. There are multiple reasons being tossed around for this increased volatility. They blame the uncertainty over a September rate hike as well as the potential for an accelerated rate hike bias because the chatter from half the board has become increasingly hawkish. North Korea's nuclear test, submarine launched ballistic missiles, Iran threatening to shoot down U.S. planes and China warning countries not to approach their newly built islands in the South China Sea are also causing uncertainty. Investors worry we are close to a flash point where one or more of those events could erupt into a shooting confrontation.

There is also the election. With the polls tightening and the lead changing in some of the critical swing states, Clinton is no longer being projected as the likely winner. A Clinton win was already factored into the market and with republicans in control of the House and Senate, analysts were projecting four years of relative calm because of the divided government. If Trump wins, there is significant potential for an upset to the status quo. In theory, there would be republican control of all three branches although Trump is only barely considered a republican. Also, the House and Senate would definitely not be rubber-stamping any of his requests. There could be a deadlock of a different sort but as we have seen in the primary, it is foolish to count him out. He is a force to be reckoned with similar to a runaway bulldozer.

The potential for a Trump win, upset the historical trend in the market. I have written before that a lopsided contest in August tended to pull the Q4 rally forward because the uncertainty had been removed. We saw that in August when the polls were showing a double digit lead for Clinton. Now that it is a dead heat, that uncertainty has returned and the volatility spiked.

Lastly, over the last week the feeling over the path of the global central banks has changed. With $13 trillion in bonds with negative yields and $15 trillion on the balance sheets of the major central banks, the outlook has turned to uncertainty. The current global stimulus policy is not working. Economies are not growing and monetary policy is at record levels of stimulus. Central banks are suddenly reconsidering their plans and that suggests the global economy as we know it is about to change.

Today, the yield on the ten-year treasury spiked +3.7% to 1.73% and a three-month high but the outlook for the Fed did not change.

On Friday, the chance of a September hike spiked to 24%. On Monday after the three Fed heads spoke, the odds fell back to 15%. Those odds held that same level today. The spike in yields was not directly related to the Fed but an overall worry that global stimulus was about to tighten.

On Tuesday, equities, bonds, oil and gold all sold off. This is a classic sign of worries over the global economy. If stimulus is about to tighten then economic growth, which is already minimal, could slow as well. One analyst said "We need a good recession to reset expectations." That recession may not be that far off and that is why the Fed is panicked about adding a couple more rate hikes so they have some breathing room when it finally arrives. Some analysts believe 2-3 rate hikes over the next 9 months could actually cause a recession so what is the point in hiking rates just so you can lower them again?

The only material economic report on Tuesday was the NFIB Small Business Survey. The headline optimism index fell from 94.6 to 94.4 in August. The report proved the points I made above. The survey found that 39% of respondents cited political uncertainty as a reason not to expand their businesses or hire additional employees. During August 2015 only 20% cited political uncertainty.

The calendar for Wednesday is lackluster with nothing that should move the market. Cracker Barrel earnings will probably produce more headlines than the Import & Export prices.

Thursday is the big day with the Philly Fed Manufacturing Survey, Producer Prices and Retail Sales. Thursday will be a busy day but the quadruple witching on Friday will be the main factor in any market move.

With the Fed meeting starting on Tuesday, we could see some selling into the close on Friday. It will be interesting if the normal pre-Fed rally appears on Tuesday. Typically, the day before a Fed announcement is positive.

There was not much news to move the market on Tuesday. With very few earnings and the headlines mainly about the Fed there was little in the way of single stock news.

Freeport McMoran (FCX) shares gave back their gains from Monday after they said they were selling their deepwater Gulf of Mexico assets to Anadarko Petroleum for $2 billion plus the assumption of $500 million in abandonment expenses. Anadarko is selling $2 billion in a secondary offering to pay for the acquisition. This was a bargain for Anadarko and analysts said the price was way too cheap and that weighed on FCX shares. Freeport will use $582 million of the proceeds to pay off preferred shareholders and the rest will go to debt repayment.

Anadarko will add about 80,000 Boepd of production consisting of 80% oil. It will increase their ownership in the Lucius development to 49% from 35%. The Lucius spar is in 7,100 feet of water and can produce up to 80,000 Bopd and 450 million cubic feet of gas. Capital One Securities said Anadarko paid only 2 times EBITDA, which was exceptionally cheap considering the cash flow will pay out the deal in only two years without any additional development. Seaport Global Securities said the acquisition would add $2-$3 billion in free cash flow over the next five years. Anadarko is only paying for reserves that have been proven and acquired everything else is free. Anadarko's Gulf projects will produce 155,000 Boepd by year-end of which 85% is oil.

The company is raising its capex budget to $2.8-$3.0 billion. Onshore they are adding 2 rigs to the Delaware and DJ Basin later this year and will increase activity in 2017 as well. They plan on doubling production to 600,000 Boepd over the next five years. I have always liked Anadarko and I would not hesitate to enter a new position on any future dip.

While on the topic, oil prices fell -3% on Tuesday to $44.97 and could continue to fall. Prices gained 30 cents in afterhours trading after the API inventory report showed a minor 1.4 million barrel build. The more closely watched EIA report on Wednesday is expected to show a significantly higher build this week and next to offset the -14.5 million barrel decline last week as a result of the hurricane on shipping and the closure of oil production platforms. Tankers avoided the Gulf while the hurricane was active. They should have arrived at their destinations in Louisiana and Texas last week and this week and that will boost inventory levels.

Compounding the problem the International Energy Agency (IEA) warned that rebalancing demand and supply would take longer than originally thought. They warned that 2016 demand would rise 1.3 million barrels per day and -100,000 bpd less than originally projected. For 2017, they are predicting a further slowing of demand growth to 1.2 mbpd and a reduction of -200,000 bpd from their prior forecast. The IEA said the slowing global economy made "underlying macroeconomic conditions more uncertain."

The IEA said non-OPEC supplies in August declined -300,000 bpd but OPEC production rose to offset that decline. Global oil production was 96.9 mbpd and 300,000 bpd lower than August 2015. Near record OPEC supplies offset any declines in other countries. The IEA said the stimulus effect from cheaper oil prices is fading and economic worries in developing countries are weighing on forecasts. Demand growth has declined from 1.4 mbpd in Q1 to only 800,000 bpd in Q3. "Refiners are clearly losing their appetite for more oil." "Supply will continue to outpace demand at least through the first half of 2017." Current global stockpiles are at record levels over 3.1 billion barrels.

Tesla (TSLA) and SolarCity (SCTY) received a lot of headlines after short seller Jim Chanos said Tesla could go bankrupt. He said the proposed merger between SolarCity and Tesla would bankrupt Tesla because of the major cash drain to support the solar effort. The combined companies are burning cash at the rate of $1 billion a quarter. They will constantly need to return to the capital markets to generate more cash. Some believe Tesla may need to raise up to $5 billion over the next two years just to fund its manufacturing process. If you add in another $1 billion cash drain from SolarCity, soon investors are going to stop giving Tesla any additional money.

Currently SolarCity is selling solar installations for $3.01 a watt after allowances for debt costs. Those installations are costing the company $3.05 a watt. While that may not sound like a big loss, a typical installation can be 5,000 to 10,000 watts. When they do several thousand installations a quarter, those pennies add up to a loss of $55 million last quarter. That was up from a loss of $33 million in the comparison quarter.

Chanos does not think the merger will happen. According to the merger documents being passed around, the Tesla board refused to give SolarCity a $100 million bridge loan until the merger could be consummated. If the board actually thought the deal were going through it would have been a natural loan. Instead, SolarCity had to go outside the company to acquire $305 million in additional debt at 7.4% interest.

SolarCity was trading at $27 when they agreed to the merger. The stock is now at $17.06 because of the decline in TSLA shares and the expectations for the deal to collapse. SolarCity shareholders are to get 0.11 TSLA share for every SCTY share. That is $21.50 today with the actual share price significantly lower.

If the deal collapses, Tesla shares should rebound but SCTY shares could collapse further with their cash burn rate increasing and no sugar daddy to cover their overdrawn checking account.

Apple (AAPL) shares exploded higher to gain +$2.51 after carriers began to release order information on the iPhone 7. Apple said it was no longer going to release order numbers for the first few weeks of sales because those numbers were normally artificially low because of production limitations. However, carriers began spreading the good news this week.

T-Mobile said preorders for the last four days were up nearly 400% over the orders for the iPhone 6. "The first four days of the iPhone 7 launch are by far the biggest ever for T-Mobile" according to CEO John Legere. T-Mobile said existing customers can get a 32GB version for free or an iPhone 7 Plus 32gb model for $120 when they trade in their existing iPhone 6.

Sprint immediately fired back saying orders were up +375% and they would give the basic iPhone 7 for free with any trade in of a smartphone including the Samsung Galaxy S7. Sprint is also discounting the 256gb phones by $100.

The headlines on the surge in orders lifted Apple shares in a bad market. Shares hit a low of $102.43 on Monday and closed at $108 today.

After the bell, Carl Icahn said he had asked the SEC for the option to increase his stake in Herbalife (HLF) from 35% to 50%. He currently owns just over 20% of the outstanding shares and the company has given him permission to own up to 35%. He said Herbalife would be better off as a private company and be rid of Bill Ackman. Herbalife shares rose 2.5% in afterhours.

I believe most of Icahn's comments are just publicity designed to support the stock price. Icahn is enjoying the pain he is inflicting on Ackman's $1 billion short. They snipe at each other weekly but in this particular street fight, Icahn has the hammer. Ackman's carrying costs rise every month as the stock continues to trade above $55. The time is running out on Ackman's put options that he owns in addition to the stock he is short. If Icahn can keep the price over $55 through January, it could cost Ackman a lot of money.

Markets

This is shaping up to be a September to remember. After a return to the lows on Tuesday, the S&P futures are up more than 6 points and steadily rising in the afterhour's session. While that could be reversed before morning, another short squeeze bounce is always possible.

The key for me is not the major indexes but the prior leaders in the S&P-400 and S&P-600. The S&P-600 closed at a two month low with a nearly -2% decline. There was a minor rebound but it closed very near to a potential support break.

So far, the S&P-600 has not broken out of the consolidation pattern since mid July. The uptrend is still intact. If the 730.50 support is broken it could spoil market sentiment. The small cap indexes have been the strongest performers and breaking that support would be kryptonite for the broader market.

The S&P-400 Midcap Index was the other performance leader and the decline there has already broken below similar support. The market is collapsing one index at a time.

On the S&P-500 the prior support at 2,150 returned as resistance on Tuesday with the high for the day at 2,150.47 and the opening print. The S&P has flirted with the light support at 2,130 for the last three days but it has not been convincing. The 2100-2105 level could be tested on any further decline and that should be decent support.

However, with the return of volatility we could see major moves in either direction that disregard established support and resistance levels. For instance, the rebound on Monday blew through the 2,150 level to the upside but as soon as that short squeeze cooled that level returned as strong resistance.

The Dow was crushed by declines in financials and energy stocks. Apple was the only component in positive territory and that gain helped lift the Dow from the -297 point intraday low. There is nothing on the horizon to lift the Dow from a single stock perspective but it will be very reactive to further Fed rumors.

Thank you Apple for not letting the damage be worse. Yesterday the winners list and losers list were an almost exact opposite of today's lists. Amazon, Google, Biogen, PriceLine, Tree were all in the top ten on the winners list. Today they are the biggest losers. This is a crazy representation of portfolio managers trying to throw money at the market on the way up and then quickly removing that same money from the market on the way down. They want to be exposed if a real rally appears but they do not want to take on any extra risk this close to October.

The 5,100 level is now support and that is the critical level to watch.

If we have another 200+ day on the Dow on Wednesday, I may pull my hair out, what little I have left. We need the market to pick a direction and stick with it for more than 6.5 hours. Every reversal shakes out a few more trader/investors and that adds uncertainty to the market. Investors really do not care which way the market goes in the short term because they can make plans as long as it moves in one direction. If the market goes down for 3-4 consecutive days, they can watch for the support levels to be hit and jump in with some counter trend trades. If the market is moving higher, they can look for resistance levels to jump out. These alternating 200+ point days do not work for anybody but the futures traders.

I would continue to refrain from being overly long or short just in case the market continues to alternate directions. There is always another trade waiting as long as you have capital to invest when the volatility ends.